Owning high-flying stocks sells. Mutual fund companies purposely buy popular high-flying stocks before the end of quarter. When the quarterly performance reports are sent to clients, it appears the fund has owned the media’s darling stocks all along.
This process is known as “window dressing” and is about as real as the mannequins you see when window-shopping.
The Wrong Suit
Just like a nice suit might hide a beer belly, end-of-quarter window dressing covers up losing positions inside a mutual fund. The drawback is that popular high-flying stocks keep getting bid up only because they’re hot right now. But hot today doesn’t mean hot tomorrow.
Window dressing mutual funds were caught in the act again a few months ago. The 3% end-of-May rally (May 25-31) was credited to end-of-quarter window dressing. Neither managers nor investors realized the stock market’s precarious position.
Early in 2011 we pointed out why higher prices are likely but warned that a major market top was forming. We recommended to keep long positions on a very short leash once the S&P hits 1,356. The ideal target for a top of historical proportions was 1,369 to 1,382.
Dress for ‘Success’
However, fund mangers followed this “winning strategy” in May 2011 as they did in 1999 and 2000. Back in 2000, they were scrambling to own the latest dot-com darlings such as AOL (NYSE:AOL), WorldCom, Enron, Global Crossing (NASDAQ:GLBC), JDS Uniphase (NASDAQ:JDSU), Nortel, Corning (NYSE:GLW), etc. Those holdings looked good at the Q4 1999 end-of-quarter statement but turned ugly thereafter.
In 2007, it was trendy to own over-leveraged and over-confident financial conglomerates. The tech of 2000 and financial bust of 2007 taught fund managers and unfortunate investors a painful but short-lived lesson.
In both instances, the chased sectors and individual companies lost more than broad market indexes like the S&P, Dow Jones and Nasdaq. What names are being chased today?
The Valuations Picture
I guess the better question is what names were being chased. Courtesy of the summer meltdown, investors were reminded that Netflix (NASDAQ:NFLX) doesn’t cure cancer, it sells movies. That’s why Netflix shares tumbled as much as 30%.
Let’s take a look at the next generation of “leadership” companies. According to secondary exchange SharesPost Inc., Facebook was valued at $82.9 billion just a few months ago.
According to EMarketer, ad spending on Facebook will more than double to $4.05 billion this year. This is just an estimate, and nobody knows for sure Facebook’s revenue because it isn’t a publicly traded company — yet.
Is anyone considering the fact that advertising is one of the most cyclical businesses? If the economy tanks, so will advertising.
With a valuation north of $80 billion, Facebook is playing in the same valuations league (based on market capitalization) as McDonald’s (NYSE:MCD) and Disney (NYSE:DIS) and was valued twice as high as Boeing (NYSE:BA), Ford (NYSE:F), Costco (NASDAQ:COST) or Dell (NASDAQ:DELL) were in mid-August.
Priceline (NASDAQ:PCLN), an online travel agency, recently had the same market cap as Dell. Isn’t traveling one of the most economically sensitive portions of discretionary spending?
The day LinkedIn (NYSE:LNKD) went public, it briefly soared to a market cap of $11.8 billion. Today, its market cap is below $7 billion.
What About Groupon? Groupon’s business model is based on helping businesses draw customers by offering discounts from 50% to 90%. Today’s Groupon customer is conditioned to never ever pay full price. How can that be good for the economy?
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